Accounting for stock is crucial task from physical stock management to its valuation. Auditors will take a good look at your company’s stock valuation policy especially if the stock represents significant assets in the company’s accounts and high stock volume is involved.
The stock included in the balance sheet represents the company’s current assets and these assets can be turned into cash fairly quickly if necessary on the other hand, the stock value included in the balance sheet also represent the value will be excluded from the company’s profit and loss account. There are two objectives can be achieved by businesses by playing with their stock figures. They can shift the business profit from one year to another by overvaluing the stock to achieve minimum tax liability or they can create fictitious profit by undervaluing the stock.
Generally small companies may attempt to overvalue their stock in order to pay minimum corporation tax and growing businesses may try to undervalue their stock to improve their financial performance for borrowing or proposing dividends purposes.
There are three generally accepted methods of accounting stock.
1. The First In First Out (FIFO)
2. The Last In First Out (LIFO)
3. The Weighted Average Cost valuation
FIFO is widely used by many businesses. The stock valuation using FIFO is stock that is received first is also sold first. LIFO is stock received last is sold first. This is opposite of FIFO. Whereas Weighted Average Cost valuation is taking all the stock costs and divide them by the number of stock to arrive at the average cost of stock per unit.
There is no definite answer on which method of stock accounting is suitable for a business. It is dependent on the business operations. However, the stock accounting policy adopted must provide true and fair value of actual physical stock held which it is should be closest to its net realizable value or cost.
It is always a good practice to seek professional accountant for advice on stock accounting matters.
Concise Accountancy – Simple way to manage business stock